If you are a physician who is retired or nearing retirement, it's important to carefully develop a distribution strategy that takes into account income taxes. Many retirees simply withdraw money from their retirement plans without considering all their options. Here's a good example of how a little bit of tax planning can significantly improve your financial situation.
When I first met the Burns couple, they were drawing $130,000 per year from Mr. Burns' IRA account to cover their monthly living expenses of $8500 per month. Of the $130,000 taken out, $27,000 in income taxes would be due, leaving them the $102,000 needed for living expenses. The following are additional key facts:
I offered them the following steps to extend their retirement plan's longevity:
1. Simplify. First, they simplified their finances by consolidating Mr. Burns' retirement accounts into one account and the couple's multiple personal accounts into one account. This significantly reduced the amount of paperwork they were receiving and made it easier for them to monitor their investments.
2. Develop asset allocation. Consolidating their accounts made the job of developing a concise investment policy much easier to implement and manage. They decided on an initial allocation of one third of fixed income using a laddered bond strategy of $124,000 per year for 7 years. They used taxable bonds invested in the IRA account so that the earnings were tax-deferred. The remaining two thirds of income was invested in blue chip dividend-paying stocks, to be divided between their IRA and their personal account. The maximum federal tax on dividends in personal accounts is 15%.
3. Complete a tax review. Next, I conducted a tax review with the couple to determine the maximum that they could draw from Mr. Burns' IRA account while remaining in the 15% marginal tax bracket. After deductions and exemptions, this was approximately $74,000 and resulted in a tax of approximately $11,100, leaving $62,900 available to cover annual living expenses. The remaining $39,100 needed for living expenses would come from the couple's personal investment account's distributions. This will be accomplished through both dividend income and yearly portfolio rebalancing.
The end result is a more tax-efficient portfolio that reduces this couple's tax bite by about 20%, thus allowing more long-term growth opportunities for investments. If you are a retiree and don't perform an annual tax review to determine the most tax-efficient withdrawal strategy, you may be paying thousands more in income taxes than necessary.
One final point:
While this case involves a large estate, you can potentially benefit from a tax review no matter what size investment estate you have. The Burns received a tax deduction for their contributions to Mr. Burns' retirement account based on their highest marginal tax rate (36%-50%), while they are now taking the money out at an effective tax rate of less than 15%. That's tax leverage.
Stewart H. Welch III, CFPÂ®, AEP, is the founder of The
Welch Group, LLC, which specializes in providing feeonly
wealth management services to affluent retirees and
health care professionals throughout the United States. Mr. Welch has been
recognized by Money, Mutual Funds Magazine, and Worth as one of the top financial advisors in
the country. He is the coauthor of J. K. Lasser's New Rules for Estate and Tax Planning (John
Wiley & Sons, Inc; 2002). He welcomes questions or comments at 800-709-7100 or www.welch
group.com. This article was reprinted with permission from the Birmingham Post Herald.
Consult with your financial advisor before acting on this financial advice.